A few months back, some market prognosticators ventured a guess that the worst of the market dislocation was behind us.
As most in the financial community are aware, what started out as a subprime issue has spread into a severe lack of consumer confidence, draining liquidity from many sectors of the markets as never seen before, and causing “groundhog day” episodes of price losses. Subprime and Alt-A defaults, FASB mark-to-market requirements, troublesome government intervention, combined to create the perfect storm. The government has designed a $700 billion bailout in an attempt to halt the “vicious circle” that has resulted from forced security divestitures into a market with no demand. Because the government is able to “hold securities to maturity,” it will have a comparative advantage as a bidder and hopefully help prices find a floor.
The responsibility of the U.S. Treasury is to give consideration to the goals of providing financial system stability, and protecting taxpayers’ interests. The U.S. government can now take equity stakes in some participating financial institutions and will have some power over executive compensation. Before the Senate approved the bill in early October, a number of provisions were added, unrelated to the “troubled asset relief program” (TARP). These include a temporary increase of FDIC and NCUA insurance limits from $100,000 to $250,000, and some unrelated tax breaks. This is a good thing and should relieve the worry of depositors.
So, what should your credit union do in this environment?
- Market the fact that your deposits are now insured up to $250,000, and stress the financial stability and conservative philosophy of your credit union.
- Lower your deposit rates, particularly CDs. There’s no indication those rates are going up. In fact, some dealers expect overnight rates to drop to below 1 percent, so don’t lock in long-term share certificates yet! Credit unions tend to lag the market on dropping rates, with many resisting because of competitive pressures. But those institutions that continue offering higher-than-market rates can’t sustain doing that indefinitely; soon they will be in the red, if they don’t take action. Drop your rates and feel confident that you are doing the right thing.
- Issue prime, non-conforming mortgages to your qualifying members, if possible. Jumbo loans can attract rates higher than 7 percent or 8 percent; and although default rates have risen in prime loans, they are still well worth the risk.
- Those with guts: Take advantage of commercial mortgage-backed securities (CMBS) that are partially backed by Treasuries through “defeased” loans. “Defeasance” occurs when a borrower, who cannot prepay, substitutes a portfolio of Treasury bonds as collateral that replicates the original loan’s remaining cash-flow stream. Ensure that the remaining loans qualify the security as a legal investment within the NCUA Rules and Regulations. Yields for one-year securities are in excess of 6 percent. As with all investment types, do your research and your due diligence.
- Those with ample liquidity: Generate additional income via leveraged strategies, using investments such as agency hybrids. Borrowing rates are historically low, and mortgage spreads are historically high. And again, be careful with duration mismatches of the leveraged trades. Especially in today’s environment, spreads can be achieved with a combination of callables, putables and floaters with embedded cap options. The markets are anticipating that interest rates will remain low for awhile; therefore, cap costs are cheap and will provide insurance in case the unthinkable happens.
There’s no doubt these are tough economic times for markets. But by staying focused on the long-term picture, making a few adjustments and keeping a strong resolve, your credit union can tough it out.
For more information on balance-sheet strategies during any economic environment, please contact Emily Moré Hollis, CFA at ALM First Financial Advisors, (800) 752-4628, or visit www.almfirst.com.